Summary

The granddaddy of all investment strategies, value investing, has underperformed significantly in recent years.

The long-term evidence finds these periods are natural and part of the long-term trajectory of the value premium.

Staying the course with a simple, highly-structured, value-oriented portfolio can lead to significant long-term rewards.

The last 10 years have not been kind to value stocks here at home or abroad. While the Vanguard S&P 500 fund has compounded at +6.5% per year, the DFA US Large Value fund has returned +5.4% and the DFA US Small Value fund only +4.6%. Overseas, only the DFA International Small Value fund (+3.8%) bested its market-based counterpart, the Vanguard Developed Markets Index fund (+1.9%). The DFA International (Large) Value fund returned only +0.9% per year.

A decade can seem like an eternity for investors, with many making wholesale portfolio changes after just a year or two of adverse results. But the long-term evidence, which includes this recent period as well as the difficult stretch during the 1990s, reveals that there's still a value to including value stocks in your portfolio.

Portfolio Mix

1995-2015 Annualized Return

Growth of $1M

All-Stock Market Index

+8.1%

$5.2M

All-Stock Asset Class Mix

+9.9%

$7.2M

Balanced Asset Class Mix

+8.7%

$5.8M

Click to enlarge

The chart above looks at three different asset allocations, rebalanced annually back to target. We will start with the first two.

The "All-Stock Market Index" is a conventional stock portfolio consisting of 70% in the Vanguard S&P 500 and 30% in the DFA Large Cap International fund, a reasonable proxy for the EAFE Index. The second allocation, the "All-Stock Asset Class Mix," keeps 21% in the Vanguard S&P 500 fund but adds 21% in the DFA US Large Value fund, 28% in the DFA US Small Value fund, 18% in the DFA Int'l Value fund and 12% in the DFA Int'l Small Value fund. This is sensible allocation with the same geographical split as the first mix, but devotes 60% to large companies and 40% to small companies, with a strong emphasis on value stocks (50/50 growth and value in US large cap, 100% value in US small cap and international asset classes). It's simple enough to understand each holding and spread out enough so that each component contributes, but doesn't overwhelm the allocation.

Over the last 21 years, we see that the value-tilted asset class mix outperformed the traditional index portfolio by +1.8% per year, a welcome result given the slightly below-average return on stocks during this stretch. And these returns came with less than 2% more annual volatility. Almost 2% higher returns with less than 2% more fluctuation is a long-term result any investor would accept. Remarkably, this higher return came from similar value stock outperformance in the US and non-US markets. US large and small value companies beat the S&P 500 by 1.2% and 2.5% per year, international large and small value stocks beat the EAFE by 1.3% and 2.3% per year, respectively.

We can see the impact of these higher returns on a hypothetical $1M invested in each portfolio mix. It grew to a handsome $5.2M in the market index -illustrating nicely the benefit of a long-term investment in stocks. But in the asset class mix, it grew considerably more, to about $7.2M. Whether this difference was used to help an investor retire sooner, take out a larger annual retirement income stream, or provide a larger financial legacy to their loved ones, there was a lot of value in the value-oriented portfolio.

Other investors might have used the value-stock advantage as a way to earn returns more like the overall market but with less short-term volatility and more liquidity. This is the tradeoff many retirees favor. The "Balanced Asset Class Mix," with 65% in the All-Stock Asset Class allocation and 35% in short-term global bonds (DFA Five-Year Global fund), still managed a small advantage over the All-Stock Market Index mix, +8.7% to +8.1%. But it did so without the sharp declines during the 2000-2002 and 2008 markets. In the first, the Index mix lost 39% in total while the Balanced allocation actually managed a small gain of about 3%. In the second, the Index mix again lost almost 39% while the Balanced allocation lost less than 25%. And through it all, a hypothetical $1M investment in the Balanced allocation grew to $5.8M, about $600k more than the all-stock index mix.

So clearly, there's still value in value stock investing. Over time, investors have been handsomely rewarded for sticking with their value-oriented allocations, whether it's been higher overall returns with only modestly increased volatility in the case of all-stock value allocations, or market-like returns with less short-term volatility in the case of balanced portfolios.

At times, it can be unnerving to hold tight when value stocks are significantly underperforming the market - as has been the case since 2014, the two-year stretch from 2007-2008 or 1998-1999. But financial history, basic economic principles and a firm grasp on risk and return tell us you'll be rewarded for sticking it out.

Past performance is not a guarantee of future results. Mutual fund performance shown includes reinvestment of dividends and other earnings but does not reflect the deduction of investment advisory fees or other expenses except where noted. Portfolio mixes contain the benefit of hindsight and do not consider the economic or investor influence on maintaining a consistent allocation through a full market cycle. This content is provided for informational purposes and is not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services.

Disclosure:I am/we are long DFLVX DFSVX DFIVX DISVX.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.